By John Filar Atwood
The Investment Company Institute (ICI) strongly supports the regulation of companies’ climate change-related disclosures and believes that a combination of principles-based and prescriptive elements is the best approach. Among other things, ICI believes regulators should require the disclosure of Scopes 1 and 2 greenhouse gas emissions, narrative information based on the framework provided by the Financial Stability Board’s Task Force on Climate-Related Financial Disclosures (TCFD), and Form EEO-1 sustainability data.
ICI offered its views in a comment letter that responded to then-Acting Chair Allison Herren Lee’s March request for public input on climate change disclosures. The group noted that companies currently are inconsistent about what, when, and where they disclose climate change-related information. ICI seeks comparable, consistent information provided through a uniform global framework.
To develop such a framework, ICI suggested that the SEC look to its own observations about designing a disclosure framework using a combination of principles-based and prescriptive elements in Regulation S-K. Specifically, ICI noted the SEC’s comments that "limiting prescriptive disclosure requirements and emphasizing principles-based disclosure could improve disclosure by reducing the amount of information that may be irrelevant, outdated, or immaterial," but that "reducing prescriptive disclosure requirements and shifting towards more principles-based disclosure requirements may limit the comparability, consistency, and completeness of disclosure." A combination of the two approaches would be most effective, in ICI’s view.
ICI said that given that the relevance of ESG information is not always reflected in quantitative financial metrics, it is important that the underlying legal framework be applicable to non-quantitative factors. There is precedent for the SEC requiring companies to disclose non-quantifiable information, ICI continued. It cited recent amendments to Regulation S-K wherein the Commission required companies to disclose human capital resources and any human capital measures or objectives on which the company focuses in managing the business.
Materiality. ICI stated that in determining the appropriate level of disclosure, it is important to note that the existing materiality standard and existing case law do not create an independent requirement that all material information automatically be disclosed. Instead, within the context of a specific duty to disclose, materiality is the benchmark for determining what information is required to be disclosed. Any climate change-related disclosure that the SEC requires should be rooted in materiality, ICI said, so that the level of detail and granularity of data to be disclosed withinany prescribed categories of information can be benchmarked sensibly.
There is precedent for this approach, according to ICI, which cited prior SEC releases requiring disclosure relating to environmental laws that have used the materiality standard in connection with the disclosure requirements. ICI recommended that the agency take that same approach to climate change-related disclosures and indicate as part of any regulatory action that Scopes 1 and 2 greenhouse gas emissions, narrative disclosure under the TCFD framework, and Form EEO-1 human capital-related data are material to the reasonable investor.
Recommendations. In addition to the greenhouse gas, EEO-1 sustainability, and narrative TCFD-based disclosure, ICI recommended that the SEC promote the development of reporting practices, including assumptions, models, and methodologies before considering requiring companies to disclose Scope 3 greenhouse gas emissions. It also suggested that the Commission leverage private sector initiatives so that it more easily can catch up to, and solidify, the progress on sustainability-related reporting that U.S. market participants voluntarily have achieved over the past decade.
ICI recommended that the SEC take steps to address companies’ liability concerns associated with providing climate change-related information in Form 10-K to promote more fulsome disclosure. The SEC also should lead the work to promote a global baseline of consistent and comparable sustainability-related disclosure to support the global character of companies and asset managers, ICI stated.
ICI asked that the SEC not require companies to provide a new "sustainability discussion and analysis" because it is not needed given the existing requirement for management’s discussion and analysis of financial condition and operations. Similarly, ICI recommended that the SEC not mandate third-party assurance given the rapidly changing state of sustainability disclosures. Instead, ICI believes third-party assurance could be phased in over time to increase the reliability of sustainability-related information for investors provided that the benefits of doing so exceed the costs.
Global framework. As the SEC considers how to drive toward more consistent climate change-related disclosure, it should look to the experience of the European Union, ICI said. A lesson from the EU’s experience is the need to properly sequence disclosure requirements. ICI suggested that instead of requiring asset managers to disclose sustainability-related information before requiring companies in which the managers invested to provide sustainability-related disclosure, the SEC should directly require companies to provide climate change-related information, which should yield more comparable and consistent information.
ICI asked that the SEC continue to play an active role in the international dialogue on developing a global baseline of climate change-related disclosure. In seeking to establish the baseline, ICI recommended that the SEC: (1) focus on sustainability information that is not reflected in the financial accounts, but which is nevertheless material to enterprise value creation over the short, medium, and long term; (2) leverage existing global sustainability standards that have broad investor support; (3) develop a governance structure that appropriately represents the interests of investors; (4) create a balanced funding model to ensure an sustainability standards board’s independence and avoid undue influence of third parties and conflicts of interest, and (5) ensure sufficient coordination among international regulators to facilitate cohesive baseline disclosure of sustainability information.
Third-party assurance. ICI does not believe that the SEC should mandate third-party assurance at this time. Once the disclosure standards have stabilized and companies and those providing assurance have gained sufficient familiarity with them, ICI thinks assurance will improve comparability and reliability.
In the meantime, ICI recommended that the Commission require companies to develop and maintain internal controls and disclosure controls and procedures related to climate change-related reporting, provided it gives companies sufficient time to develop these controls and procedures. It also suggested that the SEC involve those that would provide third-party assurance in the development of the standards to ensure that their design facilitates third-party assurance. Finally, ICI believes any entities providing assurance should be subject to professional standards, including independence requirements and inspection and oversight.